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April 19, 1972

MEMORANDUM

TO: William A. M. Burden, Chairman 
Smithsonian Investment Policy Committee

FROM: T. Ames Wheeler, Treasurer

SUBJECT: Total Return Concept of Income -- Application to "True" Endowment Funds

Summary and Recommendation

In October 1970 the Smithsonian Board of Regents ratified the action of the Investment Policy Committee in approving the use of the "Total Return Concept of Income" as the guiding policy for the investment of Smithsonian's "quasi-endowment" funds (those in which, by the terms of the gift, principal as well as the interest and dividend yield may be used if necessary). The Committee did not at that time adopt Total Return as the guiding policy for "true endowment" funds because of uncertainty as to the legality of such action. Since that time there has been a definite trend toward legislative action to sanction this policy for the investment of endowment funds of educational institutions.

Smithsonian Institution has now obtained its own legal opinion from the Washington firm of Covington and Burling which finds that there is no legal impediment to the adoption of this policy by the Smithsonian for its true endowment funds, subject to minor specific exceptions set forth in the opinion.

It is recommended, therefore, that the Committee now extend to all of Smithsonian's applicable true endowment funds the policies of (1) establishing Maximum Total Return (dividend and interest yield plus capital gains, realized and unrealized) as the investment objective for these funds without, of course, assuming an inappropriate degree of risk, and (2) determining the income to be derived from these funds each year, not as the amount of dividend and interest yield (as at present) nor even as a portion of the total return for that given year, but rather as a prudent portion of the average total return to be obtained on these funds over an extended period, and taking into account both the present and future needs of the Institution.

In the case of quasi-endowment funds, the Committee has previously agreed that this prudent amount of income is currently deemed to be 4-1/2% of the previous 5-year running average of the market valuation of each fund as of March 31 in each year. While these guidelines are